2nd Quarter 2012 Commentary - ASTON/Veredus Select Growth Fund

2nd Quarter 2012

As we stated in our first quarter commentary, we expected to see some choppiness during the second quarter and we weren’t disappointed as Europe’s woes refuse to go away, a growth slowdown in the U.S started to unfold, the fiscal cliff is getting closer, and the Supreme Court threw a haymaker as it upheld ObamaCare. The one headwind that we are still facing within the large-cap universe is that defensive names with an emphasis on dividend yields are what worked in the second quarter—a complete about face from what was seen during the first quarter. We think the market is continuing along that theme in the short run as it is becoming clear that the market wants more clarity out of Europe and the U.S. presidential election, but once that is seen, we believe the move to “risk on” will occur again quickly.

We also think that a peak in the commodity cycle has occurred, as demand is down across the developed world and China is shifting gears more towards internal consumption. All in all, we think this is very bullish going forward. Economically and politically we view this year is very analogous to the summer of 1980, the only difference being that era was dealing with inflation and now we are dealing with deflation. During that year, the market had an 18% correction from early February to April and then promptly rallied 40% off the bottom into the election. We are not saying that is going to happen. Our point is that a lot of bad economic news has already been priced into the stock market. Granted, some major issues will need to be resolved, specifically clarity on Europe and the election, for this to happen.

Naturally, Europe is the wild card and the news from across the pond isn’t getting any better with Spanish yields now more than 7%. The simple question to ask is why isn’t the market getting crushed more? It has been our view that Germany has more to lose than anyone as the largest creditor to the periphery of Europe. The playbook was written by the U.S. and the policy missteps with Lehman Brothers in 2008—policymakers know what they have to do and Europe will kick the can down the road and put in place policies that will buy them time to rewrite the European Union—which will take several more years.

Weak Consumer Picks

The Fund lagged its Russell 1000 Growth Index benchmark during the quarter as weakness in consumer-related holdings negatively affected performance. Consumer Staples company Estee Lauder fell more than 12% on fears about its exposure to Europe, leading us to trim the position. The real culprit, though, was a position in HerbaLife which, despite reporting what we thought was a great quarter, sold off after a well-known activist hedge fund manager asked a seemingly basic question during the earnings conference call. We thought there was nothing to it, but the stock fell 33%. A number of holdings in Consumer Discretionary also dropped sharply, including Ralph Lauren, Las Vegas Sands, Lowes and CBS—all of which had performed well during the first quarter. We added some homebuilder stocks during the period which mitigated the effects somewhat, and will likely add more on future pullbacks.

An overweight to Financials hurt as well, as the bust up over the JP Morgan trade out of Europe spooked the entire area. This area is all over our screens, however, and we expect to be adding to Financials as the third quarter unfolds.

Holdings in Technology were battered on an absolute basis, though the performance of the portfolio in that sector was roughly in line with the benchmark. We feel this sector is overrepresented in the index, as we think Apple is more of a consumer electronics company than a tech firm. The same can be said for eBay and Visa. We added Apple back into the portfolio in April, in front of its quarterly earnings report, which was a huge beat relative to estimates. Networking and communications equipment names such as Cisco, Alacatel-Lucent, and Riverbed delivered tepid quarters and were detractors from performance during the period, all of which were sold.

On the positive side, Healthcare had a fine quarter in both an absolute and relative sense as we added a number of holdings in the sector to the portfolio during the quarter. HCA Holdings, the largest hospital operator in the country, led this area as it had a big response to the Supreme Court upholding the President’s healthcare plan. A substantial underweight to Energy during the quarter also aided relative returns. We are looking to add some natural gas producers as we think the spread between the price of natural gas price and oil has to eventually close, especially due to the number of rigs that are currently being laid down as well as the record heat.

We think that a lot of risk has been priced into the market already, barring some major financial player going down in Europe, as evidenced by its reaction to recent bad news. Given the current negative sentiment, fund flows into bonds, and the overall dismal attitudes of professional investors, the contrarian in us thinks that it will not take much for the market to get moving in a positive direction gain once we start to get some clarity on the issues we addressed earlier.